When you walk away from a home mortgage and allow the lender to take the home in a foreclosure, you may have tax implications to deal with afterward depending on how much of a deficit you owe. In most cases, the lender is not able to sell the house for the full amount of the mortgage, especially if you owe more than what the house is worth. With an 'underwater' house, money is still owed to the lender following the foreclosure and sheriff's sale.
Foreclosure
Once a debtor gets behind on his mortgage payment, after several late payments, the lender files for a foreclosure action in court. The foreclosure transfers ownership of the home from the homeowner to the creditor, who may then choose to sell the home to make up for the money defaulted by the homeowner.
Abandoning Mortgage
When a debtor abandons a mortgage, sometimes called walking away from the mortgage, the lender sells the house through a sheriff's sale. The sheriff's sale does not always match the amount of the mortgage defaulted on, particularly if the mortgage was for more than the value of the house.
The Mortgage Forgiveness Debt Relief Act of 2007
The Mortgage Forgiveness Debt Relief Act of 2007 prevents many homeowners from being hit with tax penalties if they do choose to walk away from a mortgage. This act applies to home mortgages defaulted on between 2007 and 2012. Types of mortgages excluded include mortgages on vacation homes and rental property.
Exceptions
Single tax filers have a limit of $1,000,000 that is forgiven, or $2,000,000 for married filers. Any mortgage amount that is canceled or forgiven by the original lender is considered income for the filer. The amount that the house is sold for after the foreclosure is deducted from the total mortgage amount. Anything left over is considered taxable income for that year.
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